Getting Started in Metals: As Public Interest in Metals Has Grown, So Has the Number of Vehicles to Access Them. Here Are the Advantages and Disadvantages of the Most Popular Instruments
McFarlin, Michael, Modern Trader
Although gold has been a tradable asset since only 1971, following President Richard Nixon's taking the Unites States off the gold standard, it and other metals now are a large portion of many traders' portfolios. A look at average daily volumes in gold futures contracts traded at CME Group over the last 10 years shows that growth in interest (see "Gaining popularity," page 44).
Now, 40 years after becoming a tradable asset, gold and other metals can be accessed in a number of ways, including traditional physical holdings, futures contracts, exchange-traded funds (ETFs) and through correlated markets such as mining stocks. Each vehicle has its own advantages and disadvantages, but with so many options available, investors of all types should be able to find a product to match their temperament.
Physical holdings Futures & options Exchange-traded funds
Before discussing each of the specific investment vehicles, David Meger, director of metals trading at Vision Financial Markets, reminds that, "No one vehicle is necessarily better than the others. It's all about what the comfort level of the client is, what the client is acclimated to trading and just what it is they are looking for. We can draw out the plusses and minuses of each, but at the end of the day, they're each relatively similar."
The most straightforward way of accessing metals is to buy and physically hold the actual metal in bars or coins. Stephen Platt, senior account executive at Archer Financial Services, says one of the main draws of physical holdings is security. "You actually have the metal and a lot of people feel more secure holding the actual gold," he says.
Bill Downey, analyst at GoldTrends.net, explains that people holding gold for security reasons generally hold it for its ability to retain long-term purchasing power and as insurance in case of an unforeseen event.
In addition to security and purchasing power, Platt says some people purchase physical gold as a way of transferring wealth in terms of giving it as a gift.
On the down side, Downey says people with physical holdings have to worry about liquidity. "If you are going to be trying to move product on a sharp downtrend, you're not going to get good prices for it," he says.
Trying to liquidate physical holdings quickly can be more difficult if you remove the metal from an approved warehouse because it may need to be reassessed before you can sell it. Storing metal in a warehouse necessitates a nominal storage fee, though. And possession is nine tenths of the law, as former MF Global customers learned when a bankruptcy trustee laid claim to their physical holdings in warehouses.
Ultimately, Downey says that generally physical holdings should be considered a longer-term investment because the lack of liquidity, storage fees and higher commissions can make them more difficult to trade on a shorter time horizon.
Futures contracts on metals offer the benefits of leverage and a lot of the same advantages of physical holdings because if a buyer holds the contract until expiration, he takes delivery of the metal. However, he then has to pay the full cost for 100 oz. of gold instead of margin, which usually is between 5% and 10%.
Meger says the futures markets have a number of advantages going for them. "No. 1 is liquidity and the ease of entering and exiting the market. With the futures market, you're talking about a nearly 24-hour trading platform with great liquidity. Add on top of that the ability to use leverage," he says.
Additionally, the futures markets tend to be better regulated than the physical marketplace. "It's a regulated industry vs. an unregulated industry," Platt says. "When dealing in the futures industry, there is a lot of regulation between the [Commodity Futures Trading Commission] and the [National Futures Association]. …